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When Gianmarco Mondani was in his first job as a European equity analyst at Martin Currie in Edinburgh, he discovered how much weight investors give to consensus earnings estimates in valuing a stock. At times, they didn't seem to pay attention to fundamentals such as revenue, cash flow, or market share that drove earnings. Mondani's conclusion: If he could find stocks where he could predict changes in brokerage firms' consensus estimates, he could make money for himself and his clients.

To date, his reasoning has proved sound. The 42-year-old Italian, a graduate of Scotland's Stirling University, launched his first hedge fund, Talentum, in 2002. It proved to be a highly effective vessel for investors to navigate 2008's global financial crisis, losing just 8.83% while the MSCI Europe index dropped 46%. The fund has since sprouted several variations in different currencies, the largest of which, the GAM Talentum Enhanced Europe Long/Short fund, totals $274 million. Mondani's small firm, Arkos, oversees $1 billion.

From his base near the Alps, Mondani searches for mistakes in consensus profit estimates for European companies.
Andrea Frazzetta for Barron's

Talentum—the name is derived from the ancient Greek unit of measure—is likely to become more familiar to investors, particularly in Europe, because Arkos was just purchased by GAM, the big Swiss fund operator whose money managers oversee about $53 billion and which has an aggressive distribution system. It will be rebranded as GAM.

"I concentrate on only one particular reason for share-price changes, which is changes in earnings expectations. I don't get distracted by anything else," says Mondani, whose firm is based in Lugano, a beautiful palm-fringed lakeside, Italian-speaking city in Switzerland, nestled between the Swiss Alps and Italy's northern border, where local private banks were among his first clients.

When Mondani looks at a company, the number he invariably starts with is the consensus earnings estimate for the next fiscal year. Then he talks to management. He also snaps up every research report and other available scraps of information. This doesn't tend to be too difficult because the companies he buys are usually midsize European ones that aren't heavily followed.

MONDANI AND HIS TEAM of three portfolio managers then calculate their own forward earnings estimate for the shares. Afterward, they looks at the stock's valuation. "If the information that is used in most valuation models, which is the analysts' consensus over the next couple of years, is wrong, then every single valuation model is going to have to adjust for this new information," he says. And they can make money, either by buying the stock or selling it short, depending on how the consensus must change. Talentum has a $129,000 minimum deposit and charges a 1.5% management fee and 20% of performance.

In a representative case, Mondani started evaluating European airlines in 2012. He didn't bother with the big, closely followed carriers. Instead, he focused on smaller, budget airlines like Britain's
easyJetezj.ln -1.2682926829268293%easyJet PLC ADRU.S.: OTCUSD50.6
-0.65-1.2682926829268293%
/Date(1481298139000-0600)/
Volume (Delayed 15m)
:
2039
P/E Ratio
8.63805524258254Market Cap
5021656540.16373
Dividend Yield
5.267762845849802% Rev. per Employee
612716More quote details and news »ezj.lninYour ValueYour ChangeShort position
(ticker: EZJ.U.K.). He realized that analysts were using the same bearish assumptions for easyJet that they were for bigger airlines, which were cutting flights because of a weak regional economy and high oil prices. But, based on discussion with easyJet management, he learned that budget airlines were growing and were likely to grab more market share as the bigger names retreated. He declined to discuss his earnings estimate for easyJet with Barron's, but did buy the stock for 4.90 pounds ($7.70), or nine times consensus forward earnings. EasyJet subsequently grew and raised fares; it even began collecting an added fee for reserved seats. It now trades for 13 times consensus forward earnings at £12.40 a share, and he believes it has further to fly.

Among his current long positions:
Ashtead GroupAHT.ln 2.111801242236025%Ashtead Group PLCU.K.: LondonGBP1644
342.111801242236025%
/Date(1481318188000-0600)/
Volume (Delayed 15m)
:
1042979
P/E Ratio
17.94759825327511Market Cap
8037534262.3145
Dividend Yield
0.5778588807785888% Rev. per Employee
215924More quote details and news »AHT.lninYour ValueYour ChangeShort position
(AHT.U.K.), a British company that rents construction equipment to builders, mainly in the U.S., where some rivals were so constrained by the housing slump that they couldn't upgrade their machinery. Ashtead generated enough cash and managed its debt effectively so it could spend in anticipation of a rebound. As a result, Mondani expects it to attract more customers. He bought at £2.40 a share in April 2012, when it was trading at 12 times consensus forward earnings. Since then, sell-side analysts have doubled their earnings estimates for Ashtead, which now trades at about £6.50. Talentum is holding on to the stock.

DuerrDue.xe -0.23824451410658307%Duerr AGGermany: XetraEUR79.56
-0.19-0.23824451410658307%
/Date(1481321711000-0600)/
Volume (Delayed 15m)
:
100504
P/E Ratio
16.04032258064516Market Cap
2759432865.23438
Dividend Yield
2.3252890899949725% Rev. per Employee
243352More quote details and news »Due.xeinYour ValueYour ChangeShort position
(DUE.Germany), the world's biggest maker of paint shops for auto-assembly plants, is also a favorite. Since Mondani bought the stock for about 21 euros ($28.08) in May 2012, under the assumption that a 5% increase in global car-production capacity would create demand for at least 110 new paint shops over the next five years, the price has more than doubled, to €47. Consensus estimates for forward earnings have risen by about 30%.

GAM Talentum Enhanced Europe Long/Short USD

Total Returns*

YTD

3-Yr

5-Yr

GAM Talentum Enhanced Europe Long/Short USD

9.08%

12.25%

5.14%

Barclay Equity Market Neutral Index

3.81

2.91

1.21

——————————————————————

Selected Holdings

Description

PICKS/TICKER

Ashtead Group/ AHT.U.K.

Construction equipment

easyJet/EZJ. U.K.

Budget airline

Duerr/DUE.Germany

Auto painting

Azimut/AZM.Italy

Fund management

Taylor Wimpey/ TW.U.K.

Home builder

PANS/TICKER

Sanoma/SAA1V.Finland

Publisher

*Annualized, net of fees, as of April 30. Source: Barclay Hedge

Given the worries about second-half growth, Mondani believes that his short positions hold the prospect of greater gains, though he is reluctant to be specific. Target areas include telecoms, broadcasting, publishing companies, and banks—all of which are trading at an average of 15.5 times consensus forward earnings, a market premium.

There are risks to Mondani's strategy because momentum plays a big part, says Salvatore Cordaro, chief investment officer of Tages Capital, an asset-management boutique in London that has invested more than $50 million of its clients' assets in a euro-denominated version of Talentum. When the tide turns sharply up or down, the outliers in the portfolio will underperform, he notes.

All Mondani will say is, "I run the winners, and I cut the losers." Fortunately, he's had more of the former than the latter.